Tagged: IR

Evaluation

We’re in San Francisco at the NIRI meeting, warming up with winter coming to Denver and as summer carries airily on in stocks.

What metrics do you use to evaluate your own shares, investor-relations folks, or ones you own, investors?

I don’t mean fundamentals like cash flow, growth, balance sheet data. Those describe businesses. Stocks are by and large products.

If you bristle at that assertion, it’s just math. JP Morgan and Goldman Sachs have either outright said or intimated that about 10% of their trading volumes come from fundamental investment (our data show 13.5% the past five days). Implication: The other 90% is driven by something else.

This disconnect between how investors and public companies think about stocks and what sets stock prices is to me the root of the struggle for stock pickers and IR professionals alike today.

For instance, the winds are starting to whip around the regulatory regime in Europe called MiFID II, an acronym profusion that considers securities “financial instruments” and will dramatically expand focus on data and prices – two things that power short-term trading.

For proof, one expert discussing MiFID II at TABB Forum said derivatives are “ideally suited” to the regime because they’re statistical. And a high-speed trading firm who will remain anonymous here because we like the folks running it sees MiFID II as a great trading opportunity.

Back to the question: What are your metrics?  It might not be what you’re thinking but it appears to me that the metrics most widely used by investors and companies to evaluate stocks are price and volume. Right?

But price and volume are consequences, not metrics. Think of it this way: What if meteorologists had gone to Puerto Rico and surveyed the damage and reported back that there must’ve been a hurricane?

That’s not very helpful, right? No, meteorologists forecasted the storm’s path. They offered predictive weather metrics. Forecasts didn’t prevent damage but did help people prepare.

The components of the DJIA are trading about 27 times earnings, as I wrote last week. Not adjusted earnings or expected earnings. Plain old net income. It’s a consequence of the underlying behaviors.

By understanding behaviors, we can prepare, both as investors and public companies, for what’s ahead, and gain better understanding of how the market works today.

I can summarize fifteen years of studying the evolution of the US equity market: machines are creating prices, and investors are tracking the averages. That combination creates valuations human beings studying businesses would generally find too rich.

How? Rules. Take MiFID II. It’s a system of regulation that advantages the pursuit of price based on market data, not fundamentals. In the US market, stock regulations require an intermediary for every trade. That also puts the focus on short-term prices.

Then every day by the close, all the money wanting to track some benchmark wants the best average price. So short-term price-setters can keep raising the price, and money tracking averages keeps paying it.  It’s not a choice.  It’s compliance.

In the past five days, data show the average spread between intraday high and low prices is a staggering 3%.  Yet the VIX spent most of that time below 10 and traded down to 9!

How? Machines change prices all day long, and at the close everything rushes to the average, so the VIX says there’s no volatility when volatility is rampant. Since machines are pursuing the same buy low, sell high, strategy that investors hope to execute save they do it in fractions of seconds, the prices most times end higher.

But it’s not rational thought doing the evaluating.

The lesson for IR folks and investors alike is that a market with prices set this way cannot be trusted to render accurate fundamental evaluation of business worth.

What causes it to break? Machines stop setting prices.  What causes that? There’s a topic for a future edition!  Stay tuned.

Impassively Up

A picture is worth a thousand words.

See the picture here, sparing you a thousand words (for a larger view click here). It explains our rising stock market.  Look at the line graphs.  Three move up and down, reflecting normal uncertainty and change. Just one is up like the market.  Passive Investment.

Stock market behaviors

At ModernIR, we see the market behaviorally. There are four big reasons investors and traders buy and sell, not one, so we quantify market volume daily using proprietary trade-execution metrics to see the percentages coming from each and trend them.

Were the market only matching risk-taking firms with risk-seeking capital, valuing the market would be simpler. But 39% of volume trades ticks, gambling on fleeting price-moves. About 12% pairs stocks with derivatives, down from over 13% longer term.

Less than 14% of trading volume ties directly to corporate fundamentals. So rational thought isn’t pushing stocks to records. In a sense that’s good news because most stocks don’t have financial performance justifying the 20% rise for the S&P 500 the past year.

Alert reader Alan Weissberger sent data from the St Louis Federal Reserve (click the “1Y” button at top right) showing falling corporate profits the past year. To be sure, profits don’t always connect to markets or the economy. There were rising corporate profits during the 1970, 1991 and 2001 recessions.

And corporate profits were plunging in 2007 when the Dow posted its second-fastest 1,000-point rise in history (the one from 22,000-23,000 just now is the third fastest, and both trail the quickest, in 1999 when profits were likewise falling).

Now, I’ll qualify: This picture reflects a model. Eugene Fama, the father of the Efficient Market Hypothesis, said models aren’t reality.  If they explained everything then you would need to call them reality.

But the market as we’ve modeled it with machines that bring a taciturn objectivity to the process has been driven by the sort of money that views fundamentals impassively.

You might think it surreal that 36% of volume derives from index and exchange-traded funds and other quantitative investment. Yet it makes logical sense. Blackrock and Vanguard have taken in a combined $600 billion this year says the Wall Street Journal and the two now manage nearly $12 trillion that’s largely inured to sellside analysts and your earnings calls, public companies.

And the number of public companies keeps falling, down a third the past decade. I suspect though no one has offered the math – I will buy a case of our best Colorado beer for the person with the data – that total shares of public companies (all the shares of all the companies minus ETFs and closed-end funds) has also fallen on net, 2007-present.

There you have it.  Money that simply buys equities as an asset class sliced in various ways is doing its job.  But it becomes inflation – more money chasing fewer goods. Wall Street calls it “multiple expansion,” paying more for the same thing (current Shiller PE is the highest in modern history save the dot-com bubble).

And because passive money like Gene Fama’s models doesn’t ask whether prices are correct and merely accepts market prices as they are, there’s no governor, no reasoning, that prompts it to assess its collective behavior. So as other behaviors drop off, passive money becomes the dominant force.

In that vein, look at Risk Mgmt. It reflects counterparties to investors and traders using options, futures, forwards, swaps and other derivatives to protect, substitute for or leverage stock positions. The falling percentage suggests the cost of leverage is rising.

It fits. A handful of banks like Goldman Sachs dominate the business. Goldman’s David Kostin publicly expressed concern about market values. Kostin says the stock market is in the 88th percentile of historical valuations. If banks think downside risk is higher, the cost of insuring against it or profiting on rising markets increases.

Where in the past we worried about exuberance, we should be equally wary of the impassive face of passive investment that doesn’t know it’s approaching a precipice.

I don’t think a bear market is near yet but volatility could be imminent. By our measures the market has not mean-reverted since Sept 1. It suggests target-date and other balanced funds are likely overweight in equities. When it tries to rebalance, we could have severe volatility – precisely because this money behaves passively. Or impassively.

Times and Seasons

You need examples.

I was wishing a longtime friend who turns 50 Sep 20 a happy what they call on Game of Thrones “Name Day,” and it called to mind those words. We were college freshmen 31 years ago – how time flies – and I thought back to my Logic and Philosophy professor.

He’d say in his thick Greek accent, “You need examples.  You cannot illustrate anything well with merely theory, nor can you prove something without support.”

In the stock market, examples are vital for separating theory from fact. And for helping investor-relations professionals and investors alike move past thinking “the market is complicated so my eyes glaze over” to realizing it’s just a grocery store for stocks.

With a rigid set of prescribed rules for consumers.  You can watch consumers comply. Some race around the store grabbing this or that. Others mosey the aisles loading the cart.

Timing plays a huge role. It’s not random.

I’ll give you an example.  Monday I was trading notes with a client whose shares are Overbought, pegging ten on our 10-point Sentiment scale, and 65% short.

Okay, here we go. What does “Overbought” mean? Let’s use an analogy. You know I love using spinach, right.  Overbought means all the spinach on the grocery store shelf is gone.  If the store is out of spinach, people stop consuming spinach.

What alone can override an overbought spinach market is willingness to pay UP for more spinach by driving to another store. Most consumers won’t. They’ll buy something else.

All analogies break down but you see the point?  We can measure the interplay of price and behaviors in shares so we know when they’re Overbought, Oversold, or about right — Neutral.

Now let’s introduce timing into the equation.  Monday was the one day all month with new options on stocks and other securities officially trading.  Our example stock was up 4%.  Yet it’s Overbought and 65% short.

What’s “65% short?”  That means 65% of trading volume is coming from borrowed shares. Traders are borrowing and selling shares every day to profit on short-term price-changes. It’s more than half the trading volume.

A quick and timely aside here:  We were in Chicago Friday for the NIRI chapter’s annual IR Workshop and the last panel – an awesome one spearheaded by Snap-On’s Leslie Kratcoski, an IR superstar – included the head of prime brokerage for BNP Paribas.  Among many other things, prime brokers lend securities. BNP is also a big derivatives counterparty.

Those elements dovetail in our example. The stock was Overbought and 65% short yet soared 4% yesterday. Short squeeze (forced buying), yes. But we now know WHY.

News didn’t drive price up 4%.  It was a classic case of big moves, no news. One could cast about and come up with something indirect. But let’s understand how the grocery store for your shares continuously reveals purpose.

The CONDITIONS necessary for the stock to move up 4% existed BEFORE the move.  This is why it’s vital to measure consistently.  If you’re not measuring, you’re guessing.

Why would the stock soar with new options trading?  There is demand for derivatives tied to the company’s stock. Parties short had to buy in – cover positions.  Why? Because the counterparty needed shares to back new derivatives positions (naked puts or calls are much riskier).

The stock jumped 4% because that’s how much higher the price had to move to bring new spinach, so to speak, into the market, the grocery store. Nobody wanted to sell at current prices – the stock was Overbought. Up 4%, sellers were induced to offer shares.

On any other day of the month these events would not have coalesced. I suspect hedge funds behind the bets had no idea their cloak of secrecy would be yanked off.

Once you spend a little time measuring and understanding the market, you can know in a minute or two what’s setting price. And now we know to watch into October expirations because hedge funds have made a sizeable bet, likely up (if they’re wrong they’ll be sellers ahead of expirations – and we’ll watch short volume).

Speaking of timing, options expirations for September wraps officially today with VIX and other volatility trades lapsing. The market has been on a tear. Come Thu-Fri, we’ll get a first taste of autumn.  Next week brings window-dressing for the month and quarter.

Our Sentiment Index marked a double top through expirations. About 80% of the time, an up market into expirations is a down market after, and with surging Sentiment, down could be dramatic say five or so trading days from now.

You’ll have to tell me how it goes! Karen and I are off to mark time riding bikes from Munich to Salzburg through the Bavarian Alps, a way to measure my impending 50th birthday next month.  We call it The Four B’s:  Beer, bread, brats and bikes. We’ll report back the week of Oct 9.

A Big Deal

Tim, I’m listening,” said this conference attendee, “and I’m wondering if I made the wrong career choice.” He said, “Am I going to be a compliance officer?”

We were in Boston, Karen and I, marking our wedding anniversary where the romance began: at a NIRI conference, this one on investor-relations fundamentals for newbies. I was covering market structure – the behavior of money behind price and volume – and what’s necessary to know today in IR (it wouldn’t hurt investors to know too).

It prompts reflection. The National Investor Relations Institute’s program on the fundamentals of IR that Karen and I both attended over a decade ago differed tectonically. Then, most of the money in the market was fundamental.

Companies prided themselves on closing the books fast each quarter and reporting results when peers did – or quicker.  I remember Tim Koogle hosting thousands on the Yahoo! earnings call about a week after quarter-end, the company setting a torrid pace wrapping financial results and reporting them.

Most of the money was buying results, not gambling on expectations versus outcomes. There were no high-frequency traders, no dark pools, limited derivatives arbitrage, no hint yet that passive investment using a model to track averages instead of paying humans to find better companies would be a big deal.

I’ve over these many years moved from student to faculty. I had just described the stock market today for a professional crop preparing to take IR reins, no doubt among it those who years from now will be the teachers.

I explained that the stock market possesses curious and unique characteristics. When you go to the grocery store and buy, say, a bag of spinach, you suppose the price on it is the same you’ll pay at the cash register. Imagine instead at the checkout stand the price you thought you were paying was not the same you were getting charged.

Go another step further. You had to buy it by the leaf, and someone jumped ahead of you and handed you each leaf, charging a small fee for every one.

That’s the stock market now. There is always by law a spread between the bid to buy and offer to sell, and every interaction is intermediated so regulators have a transaction trail.

I explained to the startled attendees unaware that their shares were priced this way that in my town, Denver, real estate is hot. Prices keep rising. People list houses for sale – call it the best offer to sell – and someone will offer a higher price than asked.

In the stock market today, unlike when I began in the profession, it’s against the law for anyone to bid to buy your shares for a price greater than the best offer. That’s a crossed market. Nor can the prices be the same. That’s a locked market. Verboten.

So in this market, I said, trillion of dollars have shifted from trying to find the best products in the grocery store to tracking average prices for everything. This is what indexes and exchange-traded funds do – they track the averages.

By following averages and cutting out cost associated with researching which things in the grocery store are best, money trying to be average is outperforming investors trying to buy superior products. So it’s mushroomed.

And, I said, you can’t convince the mathematical models tracking the averages to include you.  You can only influence them with governance – how you comply with all the rules burdening public companies these days, even as money is ignoring fundamental performance and choose average prices.

That’s when the question came.  See the first paragraph.

I said, “I’m glad you asked.”  Karen says I need to talk less about the problems in our profession and more about the opportunities.  Here was a chance.

“It’s the greatest time in history to be in our profession,” I said.

Here’s why. Then, we championed story, a communications job. Today IR is a true management function because money buying story is only a small part of volume. IR demands data and analytics and proactive reporting to the management and Board of Directors so they recognize that the market is driven as much by setting prices as it is by financial results.

There are $11.5 trillion of assets at Blackrock, Vanguard and State Street alone ignoring earnings calls and – importantly – the sellside.  IR courts investors and the sellside.

It’s time to expand the role beyond the message. Periods of tectonic change offer sweeping professional opportunity. Investors should think the same way: How does the market work, who succeeds in it and why, and is that helpful to our interests?

IR gets to answer that question.  It’s a big deal.  Welcome to the new IR.

Harvey Market Structure

We’ve said many prayers for friends, family and colleagues in Texas and Louisiana and will continue in the wake of Harvey. There’s a lesson from it about stocks today too.

Is paying attention to the weather forecast important?  The weather guessers were eerily accurate and I think most would agree that had Harvey hit without warning, outcomes would be factors more harrowing despite current widespread devastation.

The point of the forecasts was to prepare for outcomes, not to alter the path of the storm. Would that the latter were possible but it’s beyond our control. (Could we have lined up all the portable fans in Texas on a giant power strip fronting the gulf and blown that thing back to sea? No).

Just one thing drives me batty talking to public-company executives about market structure. It’s when they say: “If I can’t change it, why do I care about it?”

If we only measure what we can change, why do we track storms? Why mark birthdays?

In all matters human, measuring is the essential task underpinning correct conclusions, awareness, planning for the future, and separating what’s in our control from what’s not.

I’ll give you another comparative:  The solar eclipse on Aug 21.  Thanks to a rare preserved Mayan book called the Dresden Codex kept in Germany, it’s now been historically proven that Mayans could predict solar eclipses.

Their records written hundreds of years ago projected one July 11, 1991, long after they themselves were gone. Sure enough. It’s impressive that people who didn’t know the sun is 400 times larger than the moon or that the moon is 400 times nearer – creating a perfect match periodically – could do it.

But we can infer from archaeological records that they and others like the Aztecs may have used superior knowledge to dupe the less-informed.

More simplistically, a lack of understanding can produce incorrect conclusions. The fearful masses believed when the sun began to fade that the gods were angry. The rulers likely reinforced the idea to retain power.

If you don’t know an eclipse or a hurricane is coming in your shares, you conclude that a version of the angry gods explanation is behind a fall:  It must be something happening today, some news, misunderstanding of story, miscommunication by the IR team.

That’s generally untrue. Like hurricanes and eclipses, the stock market today is mathematical.  Human beings can push buttons to buy or sell things but trades are either “marketable,” or wanting to be the best buy or sell price, or “nonmarketable” and willing to wait for price to arrive.

Any order that is marketable must be automated, rules say. Automated trades are math. The market is riven with mathematical automated trades for all sorts of things and those trades, unless interdicted by something that changes, will perform in predictable ways, thanks to rules – like the ones that permit us to predict hurricanes and eclipses.

Without knowledge of those rules – market structure – you can be duped. And you are routinely duped by high-frequency traders who claim publicly to be “providing liquidity” when we observe with models all the time that they do the opposite, pushing prices higher when there are buyers and lower (and shorting stocks) when there are sellers.

If you’re routinely checking the weather forecast for your stock, you’re less likely to be duped. That’s Market Structure 101.

You may be dismayed to learn that most of your volume is driven by something other than your company’s fundamentals (unless you have lousy fundamentals, and indexes and ETFs don’t know and so value you the same as superior peers).  But you won’t be fooled again, to borrow as I’m wont to do, a song title.

The good news about market structure versus mother nature is that we can change market structure when enough of us understand that rules have been written to benefit intermediaries at the expense of investors and companies.  Knowing and seeing must come first – which requires measuring, just like satellites that tracked Harvey.

With nature, all we can do is prepare. But preparation in all things including market structure always beats its absence.

Hidden Volatility

Volatility plunged yesterday after spiking last week to a 2017 zenith thus far. But what does it mean?

“Everybody was buying vol into expirations, Tim,” you say. “Now they’re not.”

Buying vol?

“Volatility. You know.”

It’s been a long time since we talked about volatility as an asset class. We all think of stocks as an asset class, fixed income as an asset class, and so on.  But volatility?

The CBOE, Chicago Board Options Exchange, created the VIX to drive investment in volatility, or how prices change. The VIX reflects the implied forward volatility of the S&P 500, extrapolated from prices investors and traders are paying for stock futures. The lower the number the less it implies, and vice versa.

(If you want to know more, Vance Harwood offers an understandable dissection of volatility and the VIX.)

For both investor-relations professionals and investors, there’s a lesson.  Any effort to understand the stock market must consider not just buying or selling of stocks, but buying or selling of the gaps between stocks. That’s volatility.

It to me also points to a flaw in using options and futures to understand forward prices. They are mechanisms for buying volatility, not for pricing assets.

Proof is in the VIX itself. As a predictor it’s deplorable. It can only tell us about current conditions (though it’s a win for driving volatility trading). Suppose local TV news said: “Stay tuned for yesterday’s weather forecast.”

(NOTE: We’ll talk about trading dynamics at the NIRI Southwest Regional Conference here in Austin on Lady Bird Lake Aug 24-25 in breakout sessions. Join us!)

Shorting shares for fleeting periods is also a form of investing in volatility. I can think of a great example in our client base. Earlier this year it was a rock star, posting unrelenting gains. But it’s a company in an industry languishing this summer, and the stock is down.

Naturally one would think, “Investors are selling because fundamentals are weak.”

But the data show nothing of the sort! Short volume has been over 70% of trading volume this summer, and arbitrage is up 12% while investment has fallen.

Isn’t that important for management to understand? Yes, investing declined. But the drop alone prompted quantitative volatility traders to merchandise this company – and everyone is blaming the wrong thing. It’s not investors in stocks. It’s investors in volatility. Holders weren’t selling.

“But Tim,” you say. “There isn’t any volatility. Except for last week the VIX has had all the enthusiasm of a spent balloon.”

The VIX reflects closing prices. At the close, all the money wanting to be average – indexes and ETFs tracking broad measures – takes the midpoint of the bid and offer.

Do you know what’s happening intraday?  Stocks are moving 2.5% from average high to low. If the VIX were calculated using intraday prices, it would be a staggering 75 instead of 11.35, where it closed yesterday.

What’s going on? Prices are relentlessly changing. Suppose the price of everything you bought in the grocery store changed 2.5% by the time you worked your way from produce to dairy products?

Volatility is inefficiency. It increases the cost of capital (replace beta with your intraday volatility and you’ll think differently about what equity costs).  Its risk isn’t linear, manifesting intraday with no apparent consequence for long periods.

Until all at once prices collapse.

There’s more to it, but widespread volatility means prices are unstable. The stock market is a taut wire that up close vibrates chaotically. Last week, sudden slack manifested in that wire, and markets lurched. It snapped back this week as arbitragers slurped volatility.

It’s only when the wire keeps developing more slack that we run into trouble. The source of slack is mispriced assets – a separate discussion for later. For now, learn from the wire rather than the tape.  The VIX is a laconic signal incapable of forecasts.

And your stock, if it’s hewing to the mean, offers volatility traders up to 2.5% returns every day (50% in a month), and your closing price need never change.

When you slip or pop, it might be the volatility wire slapping around.  Keep that in mind.

Mercenary Prices

Florida reminded us of high-speed traders.  I’ll explain.

An energized audience and the best attendance since 2012 marked NIRI National, the investor-relations annual confab held last week, this year in Orlando.

We spent the whole conference in the spacious and biggest-ever ModernIR booth right at the gateway and in late-night revelry with friends, clients and colleagues, and I don’t think we slept more than five hours any night.  Good thing it didn’t last longer or we might have expired.

I can’t speak to content because we had no exposure. But asking people coming through the exhibit hall what moved them, we heard about IEX CEO Brad Katsuyama’s general session on the state of markets (we said hi to Brad, who was arriving in from New York about 1am as we were wrapping for the night and heading to bed).

“He said the exchanges are paying $2.7 billion to traders.”

That what folks were reporting to us.

You remember how this works, longtime readers?  The big listing duopoly doled out $500 million in incentives to traders in the most recent quarter.  That is, exchanges paid others to trade on their platforms (the rest came from BATS Global, now part of CBOE).

Both exchanges combined earned about $180 million in fees from companies to list shares. Data and services generated a combined $750 million for the two.

There’s a relationship among all three items – incentives, listing fees, data revenues.  Companies pay to list shares at an exchange. The exchange in turn pays traders to set prices for those shares. By paying traders for prices, exchanges generate price-setting data that brokers and market operators must buy to comply with rules that require they give customers best prices.

I’m not ripping on exchanges. They’re forced by rules to share customers and prices with competitors. The market is an interlinked data network. No one owns the customer, be it a trader, investor or public company. Exchanges found ways to make money out there.

But if exchanges are paying for prices, how often have you supposed incorrectly that stocks are up or down because investors are buying or selling?

At art auctions you have to prove you’ve got the wherewithal to buy the painting before you can make a bid. Nobody wants the auction house paying a bunch of anonymous shill bidders to run prices up and inflate commissions.

And you public companies, if the majority of your volume trades somewhere else because the law says exchanges have to share prices and customers, how come you don’t have to pay fees to any other exchange?  Listing fees have increased since exchanges hosted 100% of your trading.  Shouldn’t they decrease?

Investors and companies alike should know how much volume is shill bidding and what part is real (some of it is about you, much is quant).  We track that every day, by the way.

The shill bidders aren’t just noise, even if they’re paid to set prices. They hate risk, these machine traders.  They don’t like to lose money so they analyze data with fine machine-toothed combs.  They look for changes in the way money responds to their fake bids and offers meant not to own things but to get fish to take a swipe at a flicked financial fly.

Take tech stocks.  We warned beginning June 5 of waning passive investment particularly in tech. The thing that precedes falling prices is slipping demand and nobody knows it faster than Fast Traders.  Quick as spinning zeroes and ones they shift from long to short and a whole sector gives up 5%, as tech did.

Our theme at NIRI National this year was your plan for a market dominated by passive investment.  Sometime soon, IR has got to stop thinking everything is rational if billions of dollars are paid simply to create valuable data.

We’ve got to start telling CEOs and CFOs and boards.  What to do about it? First you have to understand what’s going on. And the buzz on the floor at NIRI was that traders are getting paid to set prices. Can mercenary prices be trusted?

Predictive Knowledge

Why don’t I trade like my peers?

The CEO is sure it’s because investors don’t understand something – how you manage inventory, your internal rate of return targets. Pick something.

Investors ask the same question. Why does that stock lag the group? For answers, they root through financials, technology, leadership, position in the market, to find the reason for the discount (or opportunity).

What if these assumptions are wrong?

At prompting from friend and colleague Karla Kimrey in the Rocky Mountain NIRI chapter (which we sponsor) who knows I’m a data geek, I’m reading Michael Lewis’s The Undoing Project, his latest. It’s a sort of sequel to Moneyball, about how baseball’s Oakland A’s changed professional sports with data analytics (read both and you’ll see that ModernIR is Moneyball for IR).

The Undoing Project focuses on why incorrect assumptions prevail.  I don’t have the punch line yet because I’m still reading. But I get the point already and it’s apropos for both investor-relations professionals and investors in markets that often seem to defy what we assume is the rationale behind stocks and the whole market.

Perception overwhelms reality.

The CEO, the IR professionals, investors, are all focused on the same thing. The collective assumption is that any outcome varying from expectations is a deficiency in story.  Personal perceptions have shaped our interpretation of the market’s behavior.

Yet statistically, rational thought is a minority in market volume – about 14% of it, give or take. When markets surged Monday, the Dow Jones Industrials up 183 points, we were told it was enthusiasm about earnings.

The data showed the opposite – Asset Allocation. Money that pays no attention to earnings. It’s 33% of market volume.

Why would it buy now? Because options are expiring today through Friday (and derivatives directly influence 13% of trading volume marketwide).  Asset Allocation uses options and futures to nimbly track benchmarks, and with markets down it’s probable that derivative positions were converted to the actual stocks.

But then it’s over.  Mission accomplished.  Yesterday the market gave back 114 points to go with 138 points last Thursday. The qualitative assumption – the gut instinct – that earnings enthusiasm lifted stocks Monday was not supported by subsequent data.

Daryl Morey, general manager of the Houston Rockets, gives The Undoing Project a literary push in the early pages. An MIT man and not a basketball player, Morey came into the job because team owner Leslie Alexander wanted “a Moneyball type of guy.”

He sought data-driven results.  And it worked.  Houston is in the top ranks for success with draft picks and getting to the playoffs, and other teams have copied them.

Morey says knowledge is prediction. We learn things to understand what may happen. It’s a great way to think about it. Suppose it works in IR and investing too.

It starts with questioning assumptions.  What gut instincts do you hold about your stock that you can’t support with data?  How do they compare to the data on market volume?

I know there’s a swath of people in every walk including IR and investing who think data is BS. Who cares? they’d say.  I go with my instincts. Besides, what difference does it make if we know or don’t?

Knowledge is prediction. Data align perception and reality. In Undoing, Lewis uses the Muller-Lyer illusion. Your mind perceives one line longer. Nay. Measurements prove it.

I’ll leave you with this data on the market. I wrote last week about volatility insurance.  Now we’ve got volatility.  Insurance policies are expiring right now, with the VIX today kicking off April expirations through Friday. Our Sentiment Index trend is like mid-2014.

We don’t know what may come. But we’re thinking ahead. Assumptions are necessary but should be the smallest part of expectation.

That’s a good rule of thumb in life, investing and IR (and if you want help thinking about what IR assumptions may be wrong, ask us. We may not have the answer. But we’ve got great data analytics to help sort reality from perception).

Do The Math

Anybody ever said to you, “Do the math?”

Yesterday on CNBC’s Squawk Box legendary hedge-fund manager and founder of Omega Advisors Leon Cooperman said the world is crazy.  That’s anthropomorphizing the planet but I agree. He was referring to the math behind negative interest rates, which means paying people to borrow money.  That’s crazy all right, but happening.

He also said, paraphrasing, that if the population of the country grows by 0.5% and productivity increases by 1.5%, that’s 2% economic growth.  Add in 2% inflation and you have 4% “nominal” growth, meaning the numbers add up to that figure.

He said if the S&P 500 trades at 17 times forward earnings, that puts the S&P 500 at roughly 2150, about where it is now, so the market is fully valued but not stretched.

Why should you care in the IR chair? Macro factors are dominating markets, making a grasp on economics a necessary part of the investor-relations job now.

Whether Mr. Cooperman would elaborate similarly or not, I’m going to do some math for you.  Inflation means your money doesn’t go as far as it did – things cost more.  If a widget costs $1 and the next year $1.02, why? Prices rise because the cost of making widgets is increasing.

Making stuff has two basic inputs:  Money and people. Capital and labor.  If you must spend more money to make the same stuff, then unless you can raise prices or reduce the cost of labor, your margins – which is productivity or what economists call the Solow residual – will shrink.

There’s no growth if you’re selling the same number of widgets, even if revenues increase 2%. And if prices rise, there is on the fringe of your widget market some consumer who is now priced out. That’s especially true if to retain margins you cut some labor costs by letting the receptionist go.  One more person now can’t buy widgets.

And so sales slow.

The Federal Reserve is tasked with keeping unemployment low and prices stable (a bad idea but that’s another story). Its strategy is to increase the supply of money, the theory being more money prompts hiring and rising prices are better than falling prices (errant but again for another time).

One simple way to see if that’s occurring is to look at currency in circulation on the Fed’s balance sheet.  There is now $1.5 trillion of currency in circulation, up $82 billion from a year ago.  Our economy is growing at maybe 1.5%.

In 2000, US GDP growth (right ahead of the bursting Internet bubble) was 4.1%.  In 2000, currency in circulation was $589 billion, down $30 billion from 1999 when currency in circulation grew by $100 billion over the previous year. It increased $35 billion in 1998, $31 billion in 1997.

For 2013, 2014 and 2015, currency in circulation grew $74 billion, $80 billion and $97 billion, and since July 31, 2008, before the financial crisis, currency in circulation is up $645 billion, more than total currency circulating in 2000.

Back to economic basics, what happens to the cost of stuff if money doesn’t go as far as it used to?  Prices rise.  Okay, the Fed is achieving that aim. Its plan for remedying the recession was to get prices rising.

But rising prices push some people out of the market for things.  And if to make things you’ve got to put more money to work, then something has to give or productivity declines.

It’s declining.

And if stuff costs more, people who aren’t making more money can’t buy as much stuff.  What you get is weak wages, weak growth, weak productivity. Check, check, check.

Haven’t jobs numbers been solid? We have 320 million people in this country of which 152 million have jobs. If 1% leaves every year for retirement, having kids, going to school and so on, 200,000 jobs each month is 1.5% economic growth at best.

And that’s what we’ve got.

If you want a realistic view of the economy, do the math.  At some point the rising cost of things including stocks and bonds will push some consumers out of the market.  The only head-scratching thing is what math the Fed is doing, because its math is undermining, jobs, economic growth and productivity.  It seems crazy to me.

Three Acts

Spain rocks.

We’re back from pedaling the Pyrenees and cruising the rollers of the Costa Brava on bikes, where the people, the food, the wine, the scenes, the art, the land and the sea were embracing and enriching.

To wit, we traversed 200 miles, thousands of feet of climbing and even walked some 40 miles around Barcelona and Girona and I still gained weight. But I wouldn’t trade a bite of Jamon Iberico or sip of rich red Priorat (I’ll let you look those up!).

After a night home we’re now in Chicago where I’ll speak today to the Investor Relations council for MAPI, the manufacturers’ association, on market structure, and tomorrow we’re in Austin for the NIRI Southwest Regional Conference where we sponsor and I’ll aim to rivet attendees with how IR should navigate modern markets.

Speaking of which, a perspective as September concludes this week that’s shaped by two weeks away and abroad might best work as journal entries:

Journal Entry #1:  CBOE to buy Bats Global Inc.

Years ago I sat in front of Joe Ratterman’s desk in the unassuming Lenexa, KS, BATS offices and talked about things ranging from market structure to Joe’s fondness for aircraft.  Joe is now chairman and should be able to afford a bigger plane.

But the thing to understand here is how the combination is a statement on markets. Derivatives and equities are interwoven with other asset classes. It’s what the money is doing. The market is a Rubik’s Cube where moving one square impacts others and strategies for traders and investors alike manifest in complex combinations (you clients see this all the time in our Patterns view in your Market Structure Reports).

The IR job is about building relationships with long-term money, sure. The challenge is to understand the process and method through which money moves into and out of shares. Without knowledge of the process and method, comprehension wanes – and it’s incumbent on IR to know the market. Investors and traders are not mere buyers or sellers now. Profit and protection often lie in a third dimension: Derivatives.

Journal Entry #2: The Tick Size Study. 

We reflected back to 2014 last week and revisited our comments from December that year. The exchanges at the behest of the SEC are at last embarking next month on a study of bigger spreads for buying and selling small-cap stocks to boost trading activity.

It’s a fundamentally correct idea except for one problem. And you’d think, by the way, that the Federal Reserve could grasp this pedestrian concept. Where spreads are narrow, products and services commoditize and activity moves to the path of least resistance. You understand? Low interest rates shift focus from long-term capital investment to short-term arbitrage.  Low market spreads do the same to stocks.

But the problem is the National Market System. It’s an oxymoron. Something cannot simultaneously be a market – organic commercial interaction – and a system – a process or method.  There’s either a market, or a process and method. The SEC wants to tweak the process and method to revitalize organic commercial interaction. Well, if organic commercial interaction is better, why not just eliminate the system?  The Tick Size Study is a good idea trapped within a process and method that will likely desiccate it of benefit.

Journal Entry #3:  The Market.

It too is matriculating in a process and method.  We had the Great Recession, as those who take credit for halting say.  The process and method for constraining it (for now) could be called the Great Intervention.  The third step is the Great Risk Asset Revaluation, currently underway.

In August 2014 the Fed’s balance sheet stopped expanding as the Great Intervention that followed the Great Recession halted.  In latter 2014 the stock market stopped rising. So long as the Fed’s balance sheet increased, the supply of money via credit did too, and that money chased a decreasing supply of product – stocks (because public companies are buying back more shares than they issue, collectively).  There are today fewer public companies than in 2008.  Stocks are trading roughly where they did in December 2014.

Something to ponder:  Generally when growth stocks experience slowing revenues (see Twitter for instance) or earnings, shares fall. The stock market has been in a year-long recession for both. Never in modern history has the economy not also been in recession when that occurred, nor has the market failed to retreat. That it hasn’t is testament to the inertia – a tendency to remain in a uniform state of motion – created by Intervention.

It’ll stop. And stop it must.  We’ll never have a “normal” market until then, so see it cheerfully and not with fear (inertia can last a long time too). Catch you in October.